Many Companies Still Don’t Know How to Compete in the Digital Age

The nature of disruption is changing. In the past, disruption occurred at the level of discrete product and service technologies that competed to offer better value for customers (e.g., 2.5-inch vs. 3.5-inch disk drives; LCD vs. CRT television; online vs. brick-and-mortar banks). Today, it is occurring at the level of ecosystems.

The Internet of Things is a good example of this change. Every industry, no matter how traditional — agriculture, automotive, aviation, energy — is being upended by the addition of sensors, internet connectivity, and software. Success in this environment will depend on more than just creating better digital-enabled products; it will depend on building ecosystem-level strategies that encompass the many moving pieces that come together to create the new value proposition.

Understanding and deciphering ecosystem-level disruption will be the key for executives in the coming decade. For the past 10 years, my research, writing, and consulting have focused on the question of how to build robust ecosystem strategies. There is no better illustration of the need for business leaders to expand their focus beyond traditional views of disruption than the case of Kodak.

A misunderstood story

Since its bankruptcy in 2012, Kodak has been a poster child for innovation incompetence: After inventing the world’s first digital camera in 1975, the conventional story goes, myopic managers allowed a bloated company to let inertia drive it off a cliff. Kodak stubbornly rooted itself in its high-margin, analog-photography business, let the Sonys and HPs of the world pass it by, and ultimately collapsed in a failed rear-guard effort at digital transformation.

Told this way, the Kodak story is a comforting caricature of the traditional failure to adapt to disruptive technological change. “How could they not have seen it coming?” we ask. “That’ll never be my company,” we say, confident of our own willingness to adapt:

But this story is wrong. Although Kodak had a slow start, it did, in fact, manage a miraculous, successful digital transformation. CEO George Fisher’s resignation in 2000, following a famously frustrated push for digital, set the stage for successors Dan Carp and Antonio Perez to reincarnate the company. Kodak accepted the pain of shuttering plants and laying off tens of thousands of film-factory workers. It made huge investments in new technology, new plant, and new personnel. By 2005, Kodak ranked No. 1 in U.S. digital-camera sales (No. 3 globally).

Realizing that digital offered huge margins in printer inks and photo paper, Kodak successfully transformed itself into a digital printing powerhouse. It developed over 1,000 patents related to image capture that commanded billions of dollars in licensing revenues (for access to its “218” patent alone, it was paid $550 million by Samsung and $414 million by LG). Kodak invested the rich proceeds from this critical intellectual property in creating a strong position in the digital-image-production technology — printers, papers, and inks — that was disrupting its historic analog business. It dominated the ultra-profitable, digital-photo-kiosk market, even pushing archrival Fuji out of Walgreens’s retail-pharmacy juggernaut. By 2010, Kodak had clawed its way to No. 4 in the inkjet-printer market, where it joined the likes of HP, Lexmark, and Canon.

Kodak did the wrenching hard work of changing from an analog-printing profit base to a digital-printing profit base. Yet it still failed. So what went wrong?

Kodak was so focused on its own technology transition that it missed the fact that the improvements in the very same components that gave rise to digital printing would, with further progress, undermine its very basis.

Throughout the evolution of digital printing, its success was governed, in part, by improvements in the price and performance of three components that were critical elements in the digital imaging ecosystem: charge-coupled devices (CCDs), which determined the resolution performance of digital cameras; flash memory, which determined the number of photos that could be stored on a given flash card); and LCD screens that governed the quality of image previews and the feature options that could be offered on both cameras and printers. Initially, as their price and performance improved, they made digital photos easier to take and more attractive to print, causing the sales of both digital cameras and home photo printers to accelerate.

But as CCDs got better and cheaper, they became incorporated into mobile phones, destroying the market for stand-alone digital cameras. And as flash-memory capacity grew from tens of pictures to thousands of pictures and as LCD screen resolution improved from dull and grainy towards “retinal resolution,” they caused consumers to view the lion’s share of their photos on their phones, tablets, computers and only rarely print them.

When Kodak undertook the painful process of embracing disruption and transforming itself into a digital company, its planned destination was a new way of printing photos on paper. The blind spot in its strategy and the root cause of its collapse, was its failure to see how progress in the other components of its ecosystem would eliminate the value of the end goal. Indeed, even as Kodak took advantage of these improvements to develop and sell digital picture frames, its leaders saw these as revenue-enhancing novelties rather than precursors of the game-changing shift to come. While it was Kodak’s bankruptcy that captured headlines, all the other digital-imaging darlings fell to the same forces.

What Kodak could have done

If Kodak’s leaders had appreciated the dynamics of the broader ecosystem, they would likely have made different choices.

The first step to taking an ecosystem perspective is to distinguish between situations where your ability to create value depends mostly on your own execution (product-based world) and situations where your value creation is critically impacted by the activities of other firms and technologies (ecosystem world). If you are competing in an ecosystem world, you must pay as much attention to the progress of co-innovators as to your own innovation efforts. This means recognizing when their slow development will act as a bottleneck to your own growth and when their accelerating development can fuel the growth of substitutes.

In my own work with companies, I have found that following a wide-lens process can surface these dependencies with remarkable efficiency. And with greater clarity on these dynamics, new arguments can be made for alternative strategies.

If Kodak had recognized the potential for ecosystem-based disruption, it could have pursued a number of other options:

Specialize. Compete in digital but focus on spaces that will continue to benefit from component improvements. If Kodak had anticipated the exponential increase in digital images that consumers would take and store with their ubiquitous phone cameras, it could have built its capabilities in image processing and image recognition.

Extend. Consider what side businesses might be moved to center stage. Kodak was an early mover in cloud-based photo management, most notably with the acquisition of Ofoto. But its focus was on encouraging photo sharing to drive photo printing rather than on embracing the social networking trend.

Diversify. Recognize the fragility of your position and don’t concentrate your bets. In its eagerness to push into printers, Kodak’s leaders sold off attractive parts of their company, most notably the medical imaging business. If the ecosystem-based risk had been better appreciated, they might have thought twice about putting all of Kodak’s eggs in one basket.

Harvest and husband. If you can’t come up with a positive course of action, conserve your resources until one arises. In the worst case, consider a bold retreat to a defensible niche. Kodak squandered a fortune on its digital-printer effort and in the end, did not have enough capital to mount a proper defense of its patent base.

Such alternatives were considered and debated within Kodak. But without a full appreciation of the ecosystem dynamics, they undoubtedly didn’t get the attention they deserved, easing the way to the disastrous decision to bet the company’s future on the soon-to-evaporate market for digital photo printing.

Kodak’s lesson for today’s leading firms is that risk lies not only in a lack of attentiveness to disruptive change but also in embracing the wrong part of the change. I predict that this pattern of ecosystem-based disruption — failure driven by shifting pieces rather than competition from direct rivals — will become increasingly common in the coming years as the Internet of Things evolves. From finance and manufactured goods to farms and pharmacy, the digital revolution enabled by sensors, connectivity, and distributed intelligence will upend competitive positions and strategies across the ecosystem.

Companies that learn the right lesson from Kodak’s failure — that learn to approach their competitive strategy with a wide lens that captures ecosystem dynamics — will be more likely to respond effectively to this new generation of disruptive challenges. Those that don’t risk suffering Kodak’s fate.